This comes after the Yen went on a wild ride in 2016, strengthening more than +19% through August 18th , only to weaken -14.5% into the end of the year.
Lastly, the Eurozone, as measured by the MSCI EMU Index, rose +6.98% in December, and +5.46% on the year in local currency, thanks to a weaker Euro. Finally, at the sector level, Energy, Utilities, and Financials led the way, gaining +6.38%, +3.95%, and +3.28%, respectively in December. Real Estate and Technology were notable laggards, returning -0.21% and +0.05%, respectively on the month.
Fixed Income
The broader bond market managed to eke out gains in December despite president-elect Trump’s pro-growth agenda AND a Federal Reserve interest rate hike. Alas, it wasn’t enough to salvage the quarter as bonds finished largely in the red.
Having touched all-time lows in mid-summer, bond yields are widely expected to begin a slow drift higher, ending the 35+ year bond bull market. While the terminal point and the rate of change are anyone’s guess, by our lights higher interest rates should prove a boon to savers, while modest inflation should return some degree of pricing power to corporate America.
In a tight race all year long, US high yield managed to pull out a slight win over emerging market debt to claim the championship for 2016. The Merrill Lynch US High Yield Master II Index returned +17.5% on the year, followed closely by the ML USD Emerging Market Sovereign & Credit Index, which gained +16.0%.
Taking 3 rd place honors was the ML Municipal High Yield Index, which recovered nicely from various defaults and near-defaults to return +6.3% on the year (tax-free!). US corporates were close behind as the ML US Corporate Master Index gained +6.0%. With the November elections behind it, the Federal Reserve finally managed to raise the Fed Funds rate a quarterpoint in December. The latest Fed dot-plot would seem to indicate an additional 2-3 interest rate hikes are likely in 2017; however, as always, the FOMC will remain “data dependent”.
The market doesn’t appear to be waiting for the Fed, however, as the 2yr Treasury approaches a 1.25% yield and the 5yr touches 2.0%.
Any sort of inflation scare, or revolt by the bond vigilantes (thought to be extinct, but still very much alive), could end badly for bond investors as the limited liquidity evident in the market won’t prove nearly enough to absorb any large amount of selling.
As mentioned above, the end of the long bond bull market appears upon us.
Absent some extraneous exogenous shock to the system (geopolitical strife, domestic terrorism, severe recession), it would seem to us that bond yields have begun a slow but steady march higher. Not accustomed to losing money in the bond market, it will be interesting to see how many investors react when they begin to see losses pile up.
Our advice, as always, is remember why you own them, and if you hold on til maturity, you should be okay.
Alternative Investments
Alternative Investments mostly finished 2016 on a high note, with West Texas Intermediate (WTI) crude oil, Real Estate, Commodities, and the Dollar posting positive returns in December. The lone laggard was Gold, which fell -1.8% on the month.
WTI crude oil was the year’s top performing alternative, rising +45.0%, from $37/barrel to nearly $54/barrel, after bottoming near $26/barrel in February. Crude has rebounded on hopes that OPEC follows through with planned production cuts, and an uptick in global growth will drawdown stockpiles and spur demand.
While this remains to be seen in 2017, it is important to point out that WTI crude oil is currently trading at its highest monthly close in more than 18 months, with strategists forecasting continued gains this year.
The rally in crude buoyed Commodities, as measured by the Bloomberg Commodities Index, by +1.8% in December and +11.4% in 2016. Additionally, Real Estate, as measured by the FTSE NAREIT All REIT Index, rose +3.5% in December, and +5.0% on the year.
Real Estate returns were diminished in the second half of 2016 as interest rates bottomed and rose sharply higher; however, moving forward, REITs should continue to do well, even in a rising rate environment, as the asset class remains highly sensitive to economic growth, which is expected to increase in 2017.
On the currency front, the Dollar rose +0.7% in December, and +3.6% on the year, which pushed major international currencies lower.
Diverging monetary policies in the U.S. and Europe, coupled with the sharp interest rate rise after President-elect Trump’s victory, helped push the Euro lower against the Dollar to the tune of -3.2% in 2016, but more noticeably by -6.4% in the fourth quarter alone.
Other currencies that weakened sharply against the Dollar were the Pound and Yen, which lost -4.9% and -15.4% against the Dollar in the fourth quarter. For the year, the Pound shed -16.3% against the Dollar thanks to the sharp decline post-Brexit, while the Yen actually strengthened against the Dollar by +2.7% for the year.
As for Gold, the precious metal lost -1.8% in December, but managed to gain +8.6% on the year, despite higher interest rates and a stronger Dollar.
Finally, Hedge Funds had another tough year, with most strategies underperforming the S&P 500 (again). The standout strategies were Distressed Securities and Event Driven, which gained +20.64% and +11.12% respectively on the year.